Big Advances Can Follow Big Drops

Canterbury Volatility Index is at CVI = 44 (Bullish): The CVI (volatility) declined another 3 points last week and is only 3 points away from its lowest level registered in early July.

Keep in mind that extremely low volatility will sometimes bring the "one day outlier” we have discussed many times in the past. Markets are supposed to move. Slow markets mean complacency among investors. Complacency will sometimes end with a knee jerk reaction to an unexpected short term event. The important point to remember is that such moves are just part of the random market noise and will have little impact on the overall trend.

Overbought/Oversold "Oscillator” remained at the same 99% overbought as the previous week (short term Bearish). Our overbought oversold indicator ranges from 100% overbought (Bearish) to 100% oversold (Bullish). A reading of 95% overbought or oversold is considered to be an extreme reading. The current overbought nature of the market environment makes a short term blip down even more likely.

Market Comment:>August was a good month for most stocks and bonds. The Emerging markets in Asia and NASDAQ 100 are the top two style indexes on the Portfolio Thermostat’s volatility weighted strength list. Technology, Health Care, and Consumer Staples are currently the three strongest sectors. Canada, Real Estate and the Transportation Industry are also near the top of the list.

Most of the Portfolio Thermostat’s medium and long term indicators are Bullish but the market is short term overextended. The most likely direction from here is a short term pullback.

Interesting Observation:>Can you believe that the Barclay’s Capital 20 year Treasury bond index is up 18.92% year to date? Many recall last year’s (2013) drubbing when the Treasury bond index was down -13.88%. Here is the year to date returns of four major market indexes:

It would appear that the old (buy and hold) 60% Stock and 40% Bond allocation is the way to go. Or maybe we should sell stocks and buy bonds. But wait! Should we make major changes in our long term investment philosophy based on 8 months of market data?

Let’s look at a few different time periods and see what they would look like:

The returns show that US Treasury bonds have been, by far, the best asset class so far this year (2014). We can also see that 20 year Treasuries were the worst major market index last year (2013). In fact, the lowest point for Treasuries was at the end 2013 and the highest point was last Friday.

Over the last 16 months, Treasury bonds have had the worst returns and highest risk/volatility. So much for traditional investment management’s Keystone assumption: the risk/return relationship. Taking "more risk” does not provide higher returns over the long run.

Think about it. If risk is defined as losing money or volatility, then how would accepting more volatility, meaning accepting larger losses, relate to actually making money in a portfolio. We know that large fluctuations work against us. Every decline requires a higher percentage advance to get back to even. For example, a 50% decline in value requires 100% advance to get whole. In addition, high or increasing volatility is a primary characteristic of a Bear market environment. Should we hope for volatile Bear markets so that we accept more risk, lose more money so we can make more money? Where is the logic in that?

Large short term advances tend to follow large declines. Bull markets tend to be kind of boring and sluggish. Bull markets have periods of trading sideways and pullbacks in the 5% to 10% range. These "pullbacks” are typically followed by new highs. All market classes and securities will have both, Bull and Bear market environments.> >Bottom Line:>Short term performance can be misleading and is easy to take out of context. Markets will ebb and flow over time. The key to managing a portfolio is all about risk management. An effective risk management process must be able to maintain portfolio minimum fluctuations (noise) and avoid substantial declines. The portfolio Thermostat model has had many periods of high short term gains but the key to its success has been risk management.

Source for the above returns: Orion Advisors.

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), makes all the final decisions on all investment and portfolio management decisions for Canterbury Investment Management. Tom has more than 30 years experience in the investment management industry and has broad breadth of knowledge. He is known as an innovator, educator and been revolutionary in the advancements in portfolio and risk management.

Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.